Introduction

What is Federal Credit

The U.S. government uses federal credit (direct loans and loan guarantees) to allocate financial capital to a range of areas, including home ownership, higher education, small business, agriculture, and energy. The Federal Credit Reform Act of 1990, or FCRA, changed how the unified budget reports the cost of federal credit activities. FCRA required that the reported budgetary cost of a credit program equal the estimated subsidy costs at the time the credit is provided. The FCRA defines the subsidy cost as “the estimated long-term cost to the government of a direct loan or a loan guarantee, calculated on a net present value basis, excluding administrative costs.”

Federal Credit Supplement

This analysis uses the data reported in the Federal Credit Supplement to the FY2016 President’s Budget. It contains information about the federal government’s credit market activities—for example, lending authority and estimated credit costs. It is a combination of policy targets proposed by the administration, supported by some quantitative assumptions.

Program Search (FY 2016)

Moody’s Credit Rating Calibration

Each credit program was assigned an estimated Moody’s credit rating based on the program’s default rate (net of recoveries) and the term to maturity of its loans. It’s important to emphasize that these programs have not been rated by Moody’s or any other credit agency. This analysis is an attempt to put federal credit programs into a more conventional risk management perspective

The ratings were calibrated based on the following data:
Moody’s Average Cumulative Issuer-Weighted Global Default Rates, 1970-2010.

Subsidy Rate Components

Default Rates Distribution

This chart illustrates the linear relationship between the default rate and subsidy rate component due to defaults. The color of the circles represents different levels of Moody’s credit ratings.

Default Rate Assumptions

Direct Loans Borrower Interest Rates

Different credit programs may expect to charge the borrowers interest rates as low as 0% and as high as 7.66% (see the table above). This chart illustrates that borrower interest rate is the primary driver of direct loans’ subsidy rate component due to interest. As expected, the lower the rate charged to the borrower, the higher the subsidy cost.

Notably, Student Loans appear to have the highest interest rates.

Dollar Flow Charts

The flowing charts (also known as Sankey charts) demonstrate the many-to-many relationship between the following dimensions:

Loan Amounts

  • Credit Subsidy Type: Most programs in FY2016 operate through guarantees on loans issued by private lenders. The government’s current involvement in issuing direct loans is mostly limited to student loans from the Dept. of Education.
  • Lending Category: The overwhelming majority of federal credit support is for lending related to Housing (issued by HUD, VA, and USDA), followed by Student Loans.
  • Government Agency: Again, in terms of loan volume federal credit is dominated by HUD, followed by the Dept. of Education, VA, and USDA.
  • Credit Rating: The majority of loans have low projected default rates, corresponding to Moody’s Aaa credit rating.

Subsidy Dollar Costs of Defaults

We can also look at the dollar subsidy costs resulting from expected defaults. These amounts are calculated by multiplying loan amounts by the default subsidy rate component. The chart shows that even though a majority of the loans have low default rates corresponding to Aaa ratings, the largest portion of credit losses is expected to result from lower rated (A, Baa, and Ba) programs.

Comparison to Prior Fiscal Year

Loan Amounts by Lending Category

According to the FY2016 President’s Budget, most lending categories are expected to have an increase. Housing loans show the biggest gains.

Loan Amounts by Rate of Default

The budget assumes that most of the loans issued or guaranteed in FY2015-2016 will have very low default rates, corresponding to Moody’s investment grade credit ratings.

Subsidy Cost by Lending Category

The total budgeted subsidy cost for a program can be computed by multiplying the subsidy rate (which is the cost of subsidizing one dollar of a loan) times the total expected loan dollar amount.

The budget expects most programs’ FY2015-2016 cohorts to be operated under either zero or negative cost (making a profit) to the government. This is not surprising, considering the Treasury’s historically low borrowing costs as well as low projected default rates. However, the actual costs may increase if default rates start to go up.

Subsidy Cost Components

Breaking up the subsidy cost into components reveals that the Administration expects the direct student loans issued in FY2016 to have a substantial negative subsidy cost due to the difference between the Treasury’s borrowing costs and the interest rates charged to students. The student loans programs do not report a substantive “Default” component. Rather, the negative cost is partially offset by “Other”.

On the loan guarantees’ side, a substantial negative subsidy cost (net profit) is expected from charging fees to housing and small business borrowers.

Overall, the total subsidy cost of all FY2016 federal credit loans is projected to be $-21.1 billion dollars across the entire federal government (on a net present value basis). This low (negative) cost assumes the future defaults will not exceed the interest spread income on student loans and fee income on housing loan guarantees.

The default rate assumptions remained unchanged for most programs, with the exception of a decrease in the Energy, Transportation, and Infrastructure lending category. Interestingly, most Student Loans report negative default rates due to recovery assumptions in excess of 100%. It’s not clear from looking at the Credit Supplement, whether the Dept. of Education is actually expecting to collect more than 100% of bad debt, or if it’s some kind of reporting irregularity.

Data Sources

Download the R source code from GitHub.